thoughts and insights about social and environmental responsibility and sustainability reporting

Friday, March 2, 2012

Is Sustainability Reporting off-target?

Sustainability information, research and survey-results overload is one of the greatest challenges of the sustainability profession! It seems that every day, another informative and insightful report plops into my inbox or miraculously appears in my Twitter Stream or Google Alert. Just scanning most reports is a full time job, so being selective is a key skill. One current report that I have selectively read end-to-end is worth reviewing. Here goes:

The Metrics that Matter Report explores and documents the extent to which corporate environmental, social, and governance (ESG) information tracked and managed internally by companies is consistent with information sought by external parties, in particular, by ESG investors and the research companies that serve them.

In other words, are companies reporting what (investor) stakeholders want to know and are they doing it effectively? Great question. As Sustainability Reporting expands - CorporateRegister.com confirms 5,700 reports published in their database for 2010 and Mike Wallace of the GRI confirms roughly a 35 percent increase in GRI reporters in the U.S. from 2010 to 2011 - so the importance of the effectiveness of reporting becomes more acute. Add this to the fact that "virtually all publicly traded mid-cap to large-cap firms in the U.S. and in many other countries typically are included" in investment-focused analyses, and you can see that ESG disclosures are key to driving market impact.

The report covers five main aspects of this complex topic:
1: Background and context of reporting and investor requirements
2: Commonly used ESG metrics and why they are important
3: Analysis of metrics approach by leading rating frameworks
4: Commonalities and differences of ratings
5: Recommendations for the way forward

The major findings are:

#1 : No agreement on number of ESG metrics required

There is general agreement about the key corporate sustainability issues, but not necessarily on the specific form and number of metrics used to measure them. There is also a fundamental difference in the purpose(s) to be served by examining corporate ESG information between corporate executives and ESG researchers/investors. The IRRC report claims that there may be a "mismatch along several relevant dimensions between what ESG information companies claim they are developing and using and the information requested by external parties."

Future improvements in corporate disclosure quality and in efficient and adroit collection and use of these data in investment analysis will require improved clarity and more effective and consistent communication between companies, researchers, and the consumers of information.

The crux of the metrics

The real issue of this report, however, addresses the mismatch between what investors want to analyze and what companies track and disclose in terms of ESG metrics, and why the mismatch exists. With typical companies tracking and disclosing on 37 ESG metrics, with some tracking more than 50, and sustainability performance being reported to C-level executives or Boards of Directors at numerous companies, as well as the rise in use of the GRI guidelines, one might be forgiven for thinking that alignment between investor interest and corporate disclosure would be more consistent. Surely, all the stakeholder engagement that the increasing number of companies is now attesting to would lead to a common denominator of interests, right? Wrong. First, different investors look for different metrics. Second, dialogue is not really dialogue. Third, all that drives ESG tracking and disclosure is not wrapped up in $ bills. The Metrics that Matter Report shows that accountability and decision-making are the key drivers for the tracking of metrics within companies.

Table reproduced from the IRRC Report :
Finding Common Ground on the Metrics that Matter, February 2012

In other words, ESG data is used to help businesses manage themselves more sustainably for the long term. Isn't that great? It's not only about presenting ESG risks to investors. And here we circle back to my heretical thoughts on Integrated Reporting. Despite the fact that "ESG evaluation is all about assessing management quality, which raters believe is a key determinant of future financial outperformance", all that matters in sustainability metrics should not be investor driven. Happily, the way companies are using metrics seems to support this view. This being said, there is some correlation between demand and supply:

Table reproduced from the IRRC report - from the NAEM survey -
showing the level of analyst interest versus the number of companies that track related metrics

Most ESG researchers want disclosures on climate change, most companies provide them. Most analysts want information about diversity, most companies provide it. Most ESG researchers want health and safety data, everyone supplies it (influenced possibly, by regulation, not just voluntary disclosure). Going down the list, however, you can see the mismatch - mainly on the side of greater disclosure about things that most analysts do not (yet) consider all that important. However, the IRRC goes on to indicate that there are several other issues that ESG researchers look for which were not covered by the NAEM survey for which disclosures by corporations are less common.

Of course, companies should not ignore investor demands, and no-one (I assume) would argue against the need for greater consistency, comparability, and even correlation to financial impacts of ESG data. However, a broader perspective needs to be retained when considering what companies should track in terms of metrics and what they should disclose. This should also be informed by a company-specific materiality analysis, something which is not always present in many Sustainability Reports.

The role of the GRI

The Metrics that Matter Report maintains that "the GRI has been very helpful, but contains too many questions and imposes burdens on responding companies that may limit its uptake." The interviews conducted with various experts indicate that they generally support the concept of GRI, and believe that it has substantially improved the ESG research space. "But there was also widespread recognition that GRI may ask for too much and make it too difficult for companies to disclose important information...and..that companies that report based on the GRI guidelines put significant effort into generating these reports. One interviewee described the process as like the 'Bataan Death March [for companies] to do a report.' As a result, relatively small numbers of companies issue such reports compared to the universe of companies ESG researchers must evaluate." This is important insight, but, in my view, it is not the reporting process that presents the largest burden, but the data management processes within companies. It is not the GRI Framework that is preventing companies from reporting - after all, many companies manage to report without the GRI Framework.

I work on many Sustainability Reports for companies, and there is no doubt that the most challenging parts of the process are (1) gaining genuine stakeholder input (2) assessing material issues and (3) gathering sustainability performance data that is consistent, comprehensive and accurate. Turning this into a Sustainability Report is the easier part of the process. If investors want the data, companies need to do the work whether or not they produce a Sustainability Report which fully conforms to GRI Guidelines at whatever level. Let's not forget that the GRI Framework is extensive but not mandatory - data points which are not relevant for companies can be (and are) skipped. I have found that, for companies that are serious about sustainability, and are prepared to make the effort to put in place good data management systems for key metrics, GRI reporting is not a barrier but a beneficial tool.

The (sensible) recommendations made by the IRRC report include:

#1 : More clarity (or at least, more transparency) is needed regarding the relationships between ESG management and performance improvements and corporate financial performance.

#3 : Understand link to value creation - gaps remain in our understanding of the linkages and research illuminates a number of key issues and questions that speak to corporate value creation through adroit management of ESG issues.

#4 : Greater dialogue and sharing of informationand perspectives is essential for both sides to understand the other’s needs and constraints, and to forge communication mechanisms that are more effective and less burdensome.

My view is that in an ideal world, there would be 30 core indicators (agreed by the main body of ESG researchers, analysts, regulators, where relevant, and corporations), that are material to all companies in any sector that every company would disclose, on a regular basis, using the same methodology, for all global operations, in a way which makes a causative link between sustainability impacts and economic performance. This would achieve greater clarity, comparability and act as a basis for meaningful assessment of relative risk and opportunity. These indicators might even be the prime indicators for inclusion in Integrated Reports. Beyond the 30 core indicators, there may be another 50 - 100 sustainability performance metrics that are in the pickn'mix category, with higher or lower material relevance to different companies in different sectors and geographies. Companies could choose if, and how, to disclose against these indicators, in line with their stakeholder interest. I wonder if the revision of the GRI Framework to G4 will move in this direction?

Finally, I stress that there is much more insight and valuable information in the Metrics that Matter Report, whatever side of the equation you are on, and it is well worth the investment of time to read it in full. It contains a wealth of perspective, it's intelligently written and addresses many questions which are at the core of sustainability reporting efforts. It will certainly be useful material at the Smart Sustainability Reporting Conference in May.

Of course, I did a PDF search for "ice cream" and found none in this Report. This post, then, is a testimony to my impartial and magnanimous nature. I recommend the report anyway!